Monday, July 4, 2016

Mortgages, Student Loans, and Good Debt

Like so many other personal finance nerds, I've spent the last week digging in to JL Collins' new book, The Simple Path to Wealth. I'll spare you another positive review trying to convince you of its merits, or why you should buy it. Not my job, pal.

If you're too cheap to spend eleven bucks on the one book that will finally make you rich and happy, then don't come crying to me in six months when you find yourself destitute, friendless, eating cold pork-n-beans out of a can at the public library, and creeping everyone out.

These are your choices, Bean Can McGee. You just have to live with the consequences.

Despite all the excellent investing advice in the book (which, let's acknowledge, will make you wealthy if you just follow the simple steps Collins lays out) the part that I can't stop thinking about is his bit about the kind of debt Americans are taking on:

Indeed, it is hard to argue that it [debt] has not become "normal." As I write, here in the U.S. Americans carry a total debt burden of 12 Trillion dollars:

8 trillion in home mortgages

1 trillion in student loans

3 trillion in other consumer loans such as credit card and auto loans

Collins' main point is that you cannot ever truly build wealth if you're still buried in debt. I generally agree with this, but I am someone who believes there are very few kinds of acceptable, and even good debt.

Debt is just a tool, but it's a dangerous one. Like a table saw. Sometimes (rarely) it's the right tool for the job. Often (always) it can ruin your life if you're not careful with it.

Still, those bullet points floored me. The big problem with Americans taking on $12 trillion in debt (in addition to the figure being too large) is that the ratios of consumer, home, and student debt are out of whack. Why is the debt breakdown so lopsided, and in the wrong direction?

Consumer Debt
Let's start with the low hanging fruit. Consumer debt, which covers things like credit cards and debt taken on to buy cars, SUVs, and boats, never has a positive ROI.

Credit card debt has preposterously high interest, and acts as an albatross on all future earnings. No amount of dinners out or vacations should ever be financed at 18%. If you can't manage to pay off your credit card balance at the end of the month, you're not ready to have a credit card.

While vehicles are technically assets, they depreciate rapidly and thus make a positive ROI impossible. Low interest auto loans can potentially provide an arbitrage play and, I suppose, might allow a savvy investor avoid opportunity costs. But the juice simply is not worth the squeeze. The average car buyer does not have $30,000 in cash that he is going to invest immediately after driving home his new Honda. Rather, debt is probably his only option for acquiring that CRV, and the guy is probably buying more car than he would otherwise thanks to the debt.

Given how much of our economy is driven by consumer spending, Americans should avoid this kind of consumer debt like the plague. While some will argue they have to buy a car to get to work in the morning, or have to use credit cards to keep the lights on sometimes, these necessities' real costs are made much, much higher when purchased with debt.

Housing Debt
Homes also have a similarly dubious return on investment. I won't explain why, when there's such a good example already out there, which just happens to be from Jim Collins. Suffice it to say that, as an asset class, properties only keep up with inflation. Throw in the transaction costs, maintenance, repair, and the impact of the ongoing debt service, and renting may actually be a smarter choice for most Americans.

None of this seems to be all that convincing to the American public who, even after the housing crisis of 2008, still have a home ownership rate of 64%.

In the abstract, this may be fine since we all have to live somewhere. You either buy four walls and a roof or rent them. Buying a home can simultaneously be a poor investment (when compared to an index fund) and still be a better alternative to keeping rain off your head than renting.

Still, does that mean housing debt should represent two thirds of our total debt load, while student loans comprise just eight percent?

Student Debt
Student loans are the one and only instance where I applaud people who take on debt, if that's what they need to do to get a bachelor's degree. It's obviously better if your parents invested in a 529, or if you're able to defray some of the cost with scholarships, grants, and summer jobs.

Borrowing even $100k for that kind of payout and job security is a good bet: a no brainer, in my opinion, when you consider that college is a pretty good time, too.

Even if we ignore the less salient benefits of the college experience (i.e. - ultimate frisbee, hacky sack), taking on debt for a degree is certainly a better bet than borrowing the same $100k for a house, a few cars, a bunch of fancy vacations and restaurants, or an RV. Yet Americans are far more likely to borrow for a house or a vehicle than they are for an investment in their education.

Is it Really the Degree?
But perhaps this all just correlation instead of causation. Might these millions of college graduates just be high achievers? Could they have done just as well if they entered the workforce at 18 with a high school degree?

Perhaps, but that seems like a fairly dubious prediction. I'm of the opinion that a large part of the increased earnings and protection from recessions comes directly from the degree itself, or at least the skills and education it represents. When higher paying, white collar careers require specific degrees just to apply for an entry level position, I suppose it doesn't matter if the degree is the cause or just a correlate. It's a requirement: you're not getting the job without it.

The Best Debt
Going back to Collins' statistics, it's amazing to me that we, as a group, are opting to acquire three times as much consumer debt as student debt. The figures with housing are even more stark: Americans are taking on eight times more housing debt than student debt.

In the same vein, while 64% of all households currently own the home they live in, less than 32% of Americans over the age of 25 have ever earned a bachelor's degree.

I can respect that, in a consumer culture, we have to market things to our citizenry to keep the wheels of capitalism moving. We need people to buy a certain number of cars and refrigerators and food and houses and every type of little luxury that someone else makes their living from. We work for companies, non-profits, and governments that all produce something. If we want to sell the things we produce, then someone's got to buy. So it's no wonder we have marketing agencies blaring the siren of want, that reminds me that I need to keep buying and buying and buying if I'm ever to be cool, sexy, or happy.

But since college grads are able to earn more, and thus can spend and invest more, it would be in our collective benefit if we had a better educated and higher earning populace. Yes, these insufferable, college grad smartasses will annoy us by relaying NPR stories, unsolicited, at every opportunity. They'll throw unbearable themed dinner parties and will occasionally ruin your whole evening by blathering on about their children's "Montesorri Journey." But they will also buy more frappuccinos, massages, and therapy sessions than their high school-only counterparts. It's a tradeoff, and a good one.

But not enough people are getting degrees to make this pretentious future possible. Americans are comfortable taking on debt, but it's all the wrong kind. How do we convince these future, would-be yuppies to go to college while they're still young?

While we'll never be able to stop advertising to convince young adults that their cars and clothes define them, and that they aren't really grown up until they own a piece of land, can't we first create some propaganda about the benefits of college degrees?

I didn't touch postgraduate degrees but, depending on the field, those can have a much better payoff than even a bachelors. In general, more education translates to higher earnings.

My wife's getting her PhD and I should acknowledge that postponing your career for a decade, as some of her cohort is apparently doing, has opportunity costs that need to be entered into the analysis.

But the real benefit is getting to do a cool job that you, hopefully, are passionate about. There are a lot of neat careers out there that simply require a specific degree. If that's where your heart is, putting in the time and money at university is a no brainer.

Every time I read about America's debt numbers I get just a little nauseous. I just get this feeling in my gut that if we don't get them paid down quickly, it'll come back to bite us in the tail as individuals. Even with student loans, we're teaching our kids to put stopgaps in place now so that their loans are as small as possible: take the first two years at a community college, save cash now for college, etc. Having lived with an astronomical amount of debt, all of it scares me.

Can't disagree with any of that, Laurie. Consumer debt in particular needs to be paid off, pronto. In the case of our own personal mortgage that we're taking out, we're going to let it ride the entire 30 years due to the rate. But we technically can pay it off any time we want to, so it's always an option. Student loans are probably high enough interest that you want to pay them off asap.

All in all, I think it's better if you can go to school without any debt. I personally could not, but my wife did (including her PhD, during which she actually made a good income).

But, if you need to take out student loans to get your degree, I say go for it. Just be sure to get the degree.

Well, now I HAVE to get JL Collin's book! Jeremy, from gocurrycracker.com has been saying it's great too, so I guess it's time for me to hop on the bandwagon.

While I agree with you that having a college degree helps, not all degrees are made equal. I have friends who spent tens of thousands on degrees that not only DIDN'T help them get a job, it actually held them back by putting into them into debt. In contrast, I have friends who got a 2 year community college degree, or didn't get a degree at all, who are making 100-130K/year. One is a software developer, another is a project manager, and the 3rd is a bike mechanic in Amsterdam. So I'm a little biased on whether a degree is really that valuable. It worked out for me because I'm in STEM, but it didn't work out so well for other friends. I think a degree is valuable if you get a good ROI from it. Sadly, there are tons of degrees out there with terrible ROIs.

I hear you, FIREcracker: not all degrees are made equal. I actually majored in English, and somehow managed to pull down a good, six figure salary at the end of it (by working in business, rather than my initial field of education). Still, I think the soft skills that I obtained in college (ability to write and speak coherently, critical thinking, etc.) and the degree itself assuredly contributed to my current position and salary. In my field, you don't get promoted without at least a bachelor's degree of some kind (along with, you know, working hard and producing results).

But that's anecdotal. I'm just one example, just like your friends's situations are anecdotal. The averages are cut and dried: college graduates earn more and have higher rates of employment, on average.

Taking on student loans is certainly a risk. It doesn't always pay off. But, in general, it does, and it's a very good bet. Over a lifetime, even a modest increase in salary over that of your high-school-grad-self will make up for the cost of a student loan. I think our middle ground we can agree on is that, if you're particularly concerned with making a very good salary, then select a major that correlates.

Well gosh... I've already blathered extensively on my feelings about owning vs. renting, so I'll spare you on that topic. In terms of student loans, well I don't know. I'm grateful that I went to school back in the 1980's when I was able to get a degree from a prestigious university and come out of it with only about $15K in student loan debt. Even that felt oppressive to me at the time.

I'm really not sure what I would advise someone to do these days. It makes me feel horrible to think of these kids just starting out in the world saddled with such enormous debts. While I totally get that having a degree increases your earning potential, having that sort of debt also seriously limits your choices. At that point you basically have no alternative but to jump into the job market and try to get a really good salary - because any alternative approach would be pretty much off the table.

I honestly don't know what I would have done if I'd been in that situation, because after suffering through 4 years of hell in college (clearly you enjoyed your educational experience much more than I did) I think I might have chosen to jump off of a bridge rather than subject myself to the unending tortures of day to day life in the business world.

I guess if I had to give advice to a young person, it would be to get some real life experience under their belts before committing to something that will alter their future so inexorably. It's fine to look on your education as an investment, but I think kids need to have a clear idea of what they're signing up for, and whether they really want the future that they are locking themselves into. Just my 2 cents!

For what it's worth, only the first two years of college were "typical": in the dorms, funded via loans. The final two (okay, three) years were while working 40 hours, at a new, state university, and taking classes at night. Still, I really enjoyed my total college experience.

Depending on when in the 1980's that $15k in loans was taken, inflation changes the impact of that figure quite a bit. On the early end, in 1980 loan dollars, it's like $43k in today's dollars. If it were taken in 1989, it's only roughly doubled, to $29k in today's dollars. http://data.bls.gov/cgi-bin/cpicalc.pl?cost1=15%2C000.00&year1=1989&year2=2016

It's still interesting to put those figures into today's figures, because I'd say that someone taking on between $29k and $43k in student debt somehow seems like a lot more than $15k in 1980's dollars, even though they're (roughly) equivalent. It's just the impact of bigger figures.

I hear what you're saying about the impact of student debt. As JL Collins notes, it's not bankruptable. You're living with that debt until you pay it off: no way out.

Still, I just don't understand why anyone would be so willing to finance things like cars, every day expenses, or houses...but then is suddenly timid when it comes to financing your education.

To me, a much better-than-not chance at higher lifetime earnings is a far, far better reason to go into debt than a house, car, RV, etc. etc.

I want to see student loan debt being the "normal" debt people take on, rather than housing or, yuck, consumer debt.

I totally agree that student loan debt is infinitely better than consumer debt. And I graduated in 1990 so I guess my "real" debt was closer to $43K - interesting.

I think part of the reason I have such a strong gut level reaction to this stuff is that I was a total mess at that age. I didn't really have a choice about going to college - it was either go or be disowned by my parents. The whole experience was a miserable pressure cooker for me, and my father still hasn't forgiven me for not going on to get a higher degree.

Anyhow, I guess I think that if someone makes that sort of decision by their own volition then I have no problem with it. But unfortunately I don't think my own situation is unique, and a lot of kids get pushed into decisions that are not fully their own.

I hear that, and that's going to obviously taint the experience. I wanted to get out of the house and experience life without being under the control of my parents. So even though they wanted me to go, I was happy to take this one last 'order' from them.

In your view, do you think you earned more than you would have without a degree? Do you think that $15k was "earned back"?

Doubtful. After college I took a job answering phones at a non-profit music school for $5/hour (much to my parents' dismay), and I basically grew with the organization until I was the director, making a whopping $40K annually. Obviously, that job was not a financial calculation on my part! But I suppose the fact that I had a degree in music was somewhat helpful.

I suppose I'm a total outlier though - and since I am decidedly anti-job and anti-career, I think my views might be just a tad bit skewed from those of the general public! :-)

p.s. I do spend a lot of time wondering what I would have done if I'd simply been given the $40K in savings that instead went to paying for college. Perhaps I would have simply blown it - I dunno, but I can't help but wonder. It's kind of an interesting idea though - instead of saving to "send your kid to college" what if parents just saved up a nest egg to give their kids a head start in life.

It really is hard to know what path we might have taken if circumstances were different. I was not good at all with money when I was 18 so I would have done terribly with a huge lump sum at that age. Hell, I'd have done terribly with it at any time in my twenties.

That said, $40k invested in 1980 and simply allowed to sit in an investment, earning an average of 7% annually, would be worth about $457k today.

I can see their point: low interest rates encourage borrowing and inflate asset prices. But low interest rates and higher asset prices are not SUCH bad things, if you're financing the right things (education or, I guess, the house you live in) and/or investing in the right assets (stocks).

Yeah it seems like good advice that's out there is still not being read or appreciated. As debt and bad behaviors keep on mounting. Thanks for the review, I will give it a read. Good luck in your journey to reach freedom at 40.

There's plenty of room for improvement on the consumer debt front in particular. I'm cautiously optimistic that those figures will reduce in inflation-adjusted dollars as Americans get better at handling their money, earning more (hopefully via education), and making smarter choices on what to go into debt over.

The value of a bachelor's degree (or any degree) depends a lot on what your major is. Earning a bachelor's in dance or general studies or theatre won't necessarily help you get a job or earn higher pay.

The problem is that we don't know what the hypothetical earnings of this "other" ever will be. The college graduate imagines that her hypothetical high school graduate counterpart would earn less. Similarly, the high school graduate imagines that she might have earned more had she gotten her BA.

All we have to work from are the averages. The 32% of adult Americans who went to college and got a bachelors earn more on average. A lot more. Of course, there are exceptions within that data set, on both sides.

I totally get the "depends on what major" argument. The nuance to that is that many people tend to ignore or not understand that actually it "depends on what major from what school" decision. Brand (does the field value the brand) and quality of program matter! A dance degree from the right institution is absolutely the right thing to do. Similarly, a programming degree from say Yale is kind of a "meh" thing to do and in many ways not a smart decision at all (too much tuition, when all you really need to do is develop the technical skills and start doing).

When it comes to programming in particular, I think the skills (and a little experience you can show with those skills) matters a lot more than any degree. No one cares that you learned C++ in the mid nineties and got a BS in the process.

I'm less enthused about what school someone went to, but there are surely cases where in matters. Majoring in the humanities and wanting to get into academia w/a PhD someday? Institution matters. A lot.

But for your average job, I don't think employers are in any position to turn down good candidates with the right major/degree. There simply aren't a lot of college graduates out there.

I think a college degree is almost a requirement in most fields. The jobs that didn't require a bachelor's degree in the past often do so now. While it is almost a necessity to get one, it doesn't mean you have to get an expensive one. There are instances where the prestige of the university may be helpful, but often times a much more affordable state university works just fine. I somewhat agree with Holly about certain majors...I often wonder why students don't major in something more marketable while minoring in things they are more passionate about. It's easier said than done though...if you have no interest in a "marketable" major, chances are you may not do well in that area

I completely agree, Andrew. And that's one of the reasons I'm so floored by the ratio of the debt figures (and that only 32% of adults over 25 here have even a bachelor's degree).

If people are really concerned about stagnant wages, we should at least consider the possibility that the reason behind this situation is that 2/3rds of our populace doesn't have the education necessary for today's economy. Instead of taking on the kind of debt that might increase their lifetime earnings, they're taking on credit card and home debt.

I suppose I'm biased as an English major who's making a good salary now. I happen to think that you can usually overcome a bad major if you manage to finish and are willing to take an entry level position in other fields. And I definitely like your minor idea: in retrospect, I'd have definitely gone that route (and maybe majored in Economics).

Really interesting read that challenged some of my assumptions. "32% of Americans over the age of 25 have ever earned a bachelor's degree" - I'll admit I'm surprised that this number is so low.

That being said, I think there is a good argument to be made that *most* college students can obtain their degrees without debt (while buying a house is almost impossible without a mortgage).

I was a single mother during my college years and worked full-time graveyard shifts during my bachelor's degree to pay for tuition and living expenses. This is no "uphill in the snow both ways story". It really wasn't that bad. I did my homework at night during my shifts. There are very often good jobs for students that allow for this - mine was a residential alarm monitoring gig.

But...when I completed my first master's degree, I justified taking the full student loans available (more than $30K for 3 semesters!) so that I could complete my graduate degree without working. I so wish I hadn't done that. I easily could have worked at least a part-time job and taken out only $5-10K.

I am still paying those student loans off 10 years later. Yes, the degree boosted my income substantially and still would have been worthwhile given the debt, but it was unnecessary. I think it's clear that, especially for "poor" students, the student loans offered are outrageous amounts, and given the lack of financial experience that the typical college student has, many take out the full amount and then fritter it away, winding up in significant debt that takes decades to climb out of.

I completed my second master's degree at the cost of my employer. Not only did I learn a great deal more by completing my degree while applying the lessons in a relevant role, I didn't take on any debt. Employer education support is an underutilized opportunity to get that lucrative degree without the debt and higher education is more impactful when you have a few years of experience under your belt and have greater clarity on the direction you want for your career.

You make a good point about student debt often being in larger amounts than is truly necessary. Along with the funds for tuition and fees are extra dollars for living expenses that might not be needed.

I'm setting up a false dichotomy between housing/consumer debt and student debt, only because I think one is just so much wider to take on. Of course though, if you can manage to avoid all debt while still getting the house/degree/lifestyle you want, then all the better.

I'm especially interested in the idea that a house requires a mortgage but that a degree can be obtained without it. I think you're right: mostly because degrees are usually $100k on the high end (when considering that most students don't pay sticker price) but most houses are only going to be around $100k on the low end. Geography & school dependent, of course. And no one's giving out scholarships to buy homes.

Disclaimer: This blog is written for entertainment purposes only: not to give advice. I'm just some dude on the internet, and one without a whole lot of credentials. It's a good idea to consult with professional before making investment, tax, or financial decisions.